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March 05, 2012

Improved Penalty Disclosures On The Way

mortgage-penalty-disclosure5Two years ago to the day, the Finance Department promised to “bring greater clarity to the calculation of mortgage pre-payment penalties.”

Later this year, that promise will become realized.

The government has just announced a brand new mortgage “code” that requires federal financial institutions to:

“…provide more information on how prepayment charges are calculated.

…explain the differences between mortgage products, including ways to pay off a mortgage faster without incurring penalties.”

These improved disclosures have been eagerly anticipated by consumer groups, who charge banks with:

  • Obscuring penalty descriptions with legalese and vagueness
  • Failing to provide understandable formulas for calculating prepayment charges
  • Failing to provide consumers with easy access to the inputs (e.g., posted rates at origination, comparison rates, etc.) that must be plugged into the prepayment penalty formulas.

FCAC3Indeed, the Financial Consumer Agency of Canada (FCAC) says it “has observed a significant increase in the number of complaints it has received related to mortgage prepayment penalties,” especially interest rate differential (IRD) charges.

That’s not surprising given that many mortgage “advisers” themselves don’t even understand them fully.

The FCAC has also found cases where lenders’ actual IRD charges are different from (presumably higher than) the charges disclosed to consumers.

In short, the FCAC says that some lenders’ disclosures “hinder consumers' ability to decide on mortgage prepayment.”

mortgage-penalty-formula70Going forward, federally regulated financial institutions must disclose the following to borrowers:

  1. The method (formula) for calculating the exact prepayment charge in language that is clear, simple and not misleading
  2. Where the penalty formula is complex (e.g., uses present value), a simple way to estimate penalties
  3. A description of all inputs used in the penalty formula (including things like posted rates at originations, future value, outstanding balance, all applicable interest rates, bond yields, etc.)
  4. Information on how to obtain each of those formula inputs (or the actual values themselves)
  5. An example and/or worksheet to help consumers figure out their own prepayment penalty

November-2012-Calendar3Federally regulated lenders must be in full compliance with the above by November 5, 2012. The Financial Consumer Agency of Canada will monitor that compliance on an ongoing basis.

In addition to better penalty disclosure, lenders must also provide the following to customers annually:

  • A description of the borrower’s available prepayment privileges
  • The dollar amount of available prepayment options
  • Explanation of factors that could cause penalties to change
  • Specific information needed for the borrower to calculate his/her own penalty (e.g., the rates used to calculate the penalty, balance, etc.)
  • A list of all other fees for early repayment
  • Contact information for lender staff knowledgeable about penalty calculations.

Upon request, the lender will have to furnish a written statement with the prepayment penalty (and other amounts) to be charged, with a full description of the formula used and the timeframe for which the penalty quote is valid.

Lender will also need to provide guidance on what triggers a penalty, how to avoid penalties, and how pay down principal quicker without incurring penalties.

mortgage-penalty-calculator4And lastly (and here’s the best part in our view), lenders must post calculators on their public websites to help determine “reasonable” estimates of penalties. No more guestimators that spit out ballpark penalty quotes that are thousands of dollars off.

We don’t make a habit of celebrating government regulation, but this set of guidelines has been badly needed. Despite the lengthy implementation, the Finance Department and FCAC deserve a salute on this one.


Note: These guidelines do not apply to commercial mortgages or mortgages that don’t fall under federal regulation.


Robert McLister, CMT


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